Expect muted quarter from Reliance as refining margins stay weak: Probal Sen, IDFC Securities
GRMs are likely to be at three-year low at around $9 oeven below that, says Sen.
What are you expecting from Reliance?
It is going to be a relatively muted quarter from a quarter-on-quarter perspective, primarily because the refining margins are pretty weak right now. Even though Reliance is going to do better than most other Indian players, absolute GRMs are likely to come in at around $9 or maybe even below that. It is going to be a three, three-and-a-half-year low. It pretty much spoils the picture as far as overall earnings are concerned.
As far as some of the other segments are concerned, petrochemical continues to remain flattish, the volume momentum has already played out over the first half of the year. We do not really expect too much of volume momentum and margins particularly in the chemical segment which has been sort of flat to muted.
The downstream energy segment is going to be relatively muted. What helps them of course, is that retail and telecom continue to do very well. We expect about 8% quarter-on-quarter improvement in the retail segment EBIT and a 15% odd EBIT improvement as far as telecom is concerned. That saves the blushes but on an overall basis, we would expect EBITDA to be probably closer to about 205-206 billion which is about a 2-3% decline quarter-on-quarter and net earnings of around 94 billion odd. This is again about 1.3% lower than what they did in Q2.
The interesting thing to really look at is how much does their net debt go up by, what has been the capex so far and whether we can get any idea of what is happening to the petcoke gasification project because that is the next lever of support as far as the refining business is concerned.
What are you hoping to hear on a pricing strategy for Jio?
Without trying to step into a telecom analyst’s shoes, the only thing I can say is that as far as the telecom business is concerned, the management has always made one point that they are going to provide more value for money than rivals. They do not care where the absolute pricing is as long as the value proposition is the best. Subscriber growth and grabbing market share have continued to be priorities for Reliance. They have not really shown any inclination in the past few quarter of moving to a situation where they want to charge more money or want to get overall market pricing back up to any level.
It is very difficult to say when they will start to rationalise prices a little bit and get it up because their response always has been that as long as rivals will continue to try and undercut them, the value proposition will continue to be superior and they are going to match anything the rivals offer.
So it is something to do with the entire sector and by major industry players like Vodafone, Bharti and Jio together. As of now, any chance of a concerted policy from the three looks very difficult.
On the refining side there is already talk about refining margins picking up. But the benchmark Singapore refining margins could be under pressure and there is not much certainty on whether the uptrend can continue there. Do you think that could be a headwind?
Yes. That has been the biggest headwind for this quarter’s results and even heading into Q4, that remains a primary concern for every downstream energy player. The refining margins are at levels where we have not seen them in the last five to six years. Gasoline spreads even went negative at a certain point in Q3 which is not something we have seen in the last decade or so.
It has been a bit of a surprise just how much concerns on global economic growth have been weighing on overall product demand in major consuming nations and it is very difficult to take a call on when the recovery will happen. We remain optimistic on demand supply trends.
The refining space point to a situation where it remains tightly balanced over the next two to three years. So as and when some of these concerns on global growth get alleviated, probably some product demand will come back.
What is really weighing on the markets right now and that is true for crude prices as well as product spreads is that there are real concerns about a sustained slowdown in global economic growth. Until some signals come through specifically from China that those concerns maybe unfounded or may not be as bad as people think, product spreads could continue to remain a little bit under pressure.
What is encouraging however, at least for Reliance is that contrary to the weightage for products in the Singapore benchmark where products like gasoline and naphtha have a much higher weightage, in Indian products, diesel is much more prominent and diesel spreads have not really taken as much of a hit as has gasoline in the last three months.
So, while benchmark margins might have declined maybe a couple of dollars on a quarter-on-quarter basis, the impact on Reliance’s margins is going to be less than half of that.
Assuming that the numbers come along expected lines, is there scope for a further headroom from the current levels on the stock?
Yes. What we have really seen over last year is that maybe over the last 12 to 14 months, Reliance has just come back to where it used to trade at before the sustained period of underperformance that one saw between 2010 to 2016. Our sense is that the earnings momentum will continue to get upgraded. In recent two to three quarters, the estimates of retail earnings, in particular have been seeing an uptick. Our sense is that as the capex momentum starts to slow down and return ratios start to show substantial improvement, another round of rerating is still possible.
From here on, a very clear 15-20% upside is still there in the stock. Whether that happens in the next 12 or 18 months is something that will depend on how the capex intensity goes and how much more growth one sees in the telecom and retail businesses because downstream energy continues to do well.
If you leave aside refining which is not exactly in their control, every other expansion project that they have done is delivering returns exactly in the way that the company had guided. From that perspective, downstream energy remains in very good health. The only question is just how much more upgrades can the telecom and retail business see and as you mentioned any action on pricing will be a huge trigger that one will see over FY20 and FY21.